FRME US Equity☆

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The historical consolidated financial data discussed below reflects our historical results of operations and financial condition and should be read in conjunction with our financial statements and related notes thereto presented in Item 8 of this Annual Report on Form 10-K. In addition to historical financial data, this discussion includes certain forward-looking statements regarding events and trends that may affect our future results. Such statements are subject to risks and uncertainties that could cause our actual results to differ materially. See our cautionary “Statement Regarding Forward-Looking Statements." For a more complete discussion of the factors that could affect our future results, see “Risk Factors” under Item 1A of this Annual Report on Form 10-K.

OVERVIEW

First Merchants Corporation (the “Corporation”) is a financial holding company headquartered in Muncie, Indiana and was organized in September 1982. The Corporation’s common stock is traded on the Nasdaq’s Global Select Market System under the symbol FRME. The Corporation conducts its banking operations through First Merchants Bank (the “Bank”), a wholly-owned subsidiary that opened for business in Muncie, Indiana, in March 1893. The Bank also operates First Merchants Private Wealth Advisors (a division of First Merchants Bank). The Bank includes 109 banking locations in Indiana, Ohio, Michigan and Illinois. In addition to its branch network, the Corporation offers comprehensive electronic and mobile delivery channels to its customers. The Corporation’s business activities are currently limited to one significant business segment, which is community banking.

Through the Bank, the Corporation offers a broad range of financial services, including accepting time, savings and demand deposits; making consumer, commercial, agri-business, public finance and real estate mortgage loans; providing personal and corporate trust services; offering full-service brokerage and private wealth management; and providing letters of credit, repurchase agreements and other corporate services.

HIGHLIGHTS FOR 2021

•Net income available to stockholders for the year ended December 31, 2021 was $205.5 million compared to $148.6 million for the year ended 2020, an increase of 38.3 percent.

•Earnings per fully diluted common share for 2021 totaled $3.81 compared to $2.74 for 2020, an increase of 39.1 percent.

•The Corporation experienced organic loan growth of $566.4 million, or 6.6 percent during 2021, which when offset by a $560.5 million decline in Paycheck Protection Program (“PPP”) loans (following forgiveness by the Small Business Administration), resulted in net loan growth of $5.9 million.

•As of December 31, 2021, the Corporation had $12.7 billion in total deposits, representing a $1.4 billion increase from December 31, 2020, or 12.1 percent.

•During 2021, the Corporation repurchased 646,102 of its common shares for $25.4 million at an average price of $39.38.

•During the second quarter of 2021, the Corporation completed its previously-announced banking delivery transformation strategy, which included the consolidation of seventeen banking centers across its footprint.

•On April 1, 2021, the Bank acquired 100 percent of Hoosier Trust Company (“Hoosier”) through a merger of Hoosier with and into the Bank. The consideration paid to shareholders of Hoosier at closing was $3,225,000 in cash. Prior to the acquisition, Hoosier was an Indiana corporate trust company, headquartered in Indianapolis, Indiana, with approximately $290 million in assets under management. Hoosier’s sole office is now being operated by the Bank as a limited service trust office.

•On November 4, 2021, the Corporation and Level One Bancorp, Inc., a Michigan corporation (“Level One”) entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Level One will, subject to the terms and conditions of the Merger Agreement, merge with and into the Corporation (the “Merger”), whereupon the separate corporate existence of Level One will cease and the Corporation will survive. Immediately following the Merger, Level One's wholly owned subsidiary, Level One Bank, will be merged with and into the Bank, with the Bank as the surviving bank.

Subject to the terms and conditions of the Merger Agreement, upon the Merger becoming effective, the common shareholders of Level One will be entitled to received, for each outstanding share of Level One common stock, (a) a 0.7167 share (the “Exchange Ratio”) of the Corporation’s common stock, in a tax-free exchange, and (b) a cash payment of $10.17. The Exchange Ratio is subject to adjustments for stock splits, stock dividends, recapitalization, or similar transactions, or as otherwise described in the Merger Agreement.

Based on the number of shares of Level One common stock currently outstanding, the Corporation expects to issue approximately 5.5 million shares of its common stock, and pay approximately $77.7 million in cash, in exchange for all the issued and outstanding shares of Level One common stock. In addition, the Corporation expects to issue 10,000 shares of a newly created 7.5% non-cumulative perpetual preferred stock, with a liquidation preference of $2,500 per share, in exchange for the outstanding Level One Series B preferred stock. Based on the closing price of First Merchants’ common stock on November 3, 2021, of $43.50 per share, the implied value for a share of Level One common stock is $41.35. The aggregate transaction value is estimated at approximately $323.5 million.

The Federal Reserve and the FDIC have granted approvals in connection with the transaction. However, consummation of the Merger remains subject to the requisite approval of the holders of Level One common stock, the approval of the Indiana DFI, and satisfaction of certain customary closing conditions. The shareholders of Level One are considering the approval of the Merger Agreement on March 1, 2022, and the Indiana DFI expects to meet during March 2022 to consider the matter. The parties are diligently pursuing satisfaction of the other closing conditions and expect the closing to occur by early second quarter of 2022, subject to satisfaction of those conditions.

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COVID-19 AND RELATED LEGISLATIVE AND REGULATORY ACTIONS

On January 30, 2020, the World Health Organization (“WHO”) announced that the outbreak of COVID-19 constituted a public health emergency of international concern. On March 11, 2020, WHO declared COVID-19 to be a global pandemic and, on March 13, 2020, the President of the United States declared the COVID-19 outbreak a national emergency. In the two years since then, the pandemic has dramatically impacted global health and the economic environment, including millions of confirmed cases and deaths, business slowdowns or shutdowns, labor shortfalls, supply chain challenges, regulatory challenges, and market volatility. In response, the U.S. Congress, through the enactment of the CARES Act in March 2020, and the federal banking agencies, though rulemaking, interpretive guidance and modifications to agency policies and procedures, have taken a series of actions to provide emergency economic relief measures including, among others, the following:

Paycheck Protection Program. The CARES Act established the PPP, which is administered by the Small Business Administration (“SBA”), to fund payroll and operational costs of eligible businesses, organizations and self-employed persons during the pandemic. The Bank actively participated in assisting its customers with PPP funding during all phases of the program. The vast majority of the Bank’s PPP loans made in 2020 have two-year maturities, while the loans made in 2021 have five-year maturities. Loans under the program earn interest at a fixed rate of 1 percent. As of December 31, 2021, the Corporation had $106.6 million of PPP loans outstanding compared to the December 31, 2020 balance of $667.1 million. The Corporation will continue to monitor legislative, regulatory, and supervisory developments related to the PPP. However, it anticipates that the majority of the Bank’s remaining PPP loans will be forgiven by the SBA in accordance with the terms of the program

Loan Modifications and Troubled Debt Restructures. The CARES Act, as amended by the 2021 Consolidated Appropriations Act (the "2021 CAA"), allowed banks to suspend requirements under GAAP, effectively, through January 1, 2022, for certain loan modifications related to the COVID-19 pandemic. The federal banking agencies also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19 or offer other borrower friendly options. In accordance with such guidance, the Bank made various short-term modifications for borrowers who were current and otherwise not past due. These included short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that were insignificant.

Regulatory Capital. The CARES Act, the 2021 CAA, and certain actions by federal banking regulators resulted in modifications to, or delays in implementation of, various regulatory capital rules applicable to banking organizations. For additional information, see “Regulatory Capital” under the “CAPITAL” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

CRITICAL ACCOUNTING ESTIMATE

Generally accepted accounting principles require management to apply significant judgment to certain accounting, reporting and disclosure matters. Management must use assumptions and estimates to apply those principles where actual measurement is not possible or practical. The judgments and assumptions made are based upon historical experience or other factors that management believes to be reasonable under the circumstances. Because of the nature of the judgments and assumptions, actual results could differ from estimates, which could have a material effect on our financial condition and results of operations. For a complete discussion of the Corporation’s significant accounting policies and the adoption of ASC Topic 326, Financial Instruments – Credit Losses, see NOTE 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

As discussed in NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, the allowance for credit losses on loans is a contra-asset valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected. The amount of allowance represents management's best estimate of current expected credit losses on loans considering available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the instrument. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, the Corporation qualitatively adjusts model results for risk factors that are not inherently considered in the quantitative modeling process, but are nonetheless relevant in assessing the expected credit losses within the loan portfolio. These adjustments may increase or decrease the estimate of expected credit losses based upon the assessed level of risk for each qualitative factor. The various risks that may be considered in making qualitative adjustments include, among other things, the impact of (i) changes in the nature and volume of the loan portfolio, (ii) changes in the existence, growth and effect of any concentrations in credit, (iii) changes in lending policies and procedures, including changes in underwriting standards and practices for collections, write-offs, and recoveries, (iv) changes in the quality of the credit review function, (v) changes in the experience, ability and depth of lending management and staff, and (vi) other environmental factors such as regulatory, legal and technological considerations, as well as competition.

While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond management’s control, which includes, but is not limited to, the performance of the loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets.

RESULTS OF OPERATIONS - 2021

Net income available to stockholders for the year ended December 31, 2021 was $205.5 million compared to $148.6 million for the year ended 2020. Earnings per fully diluted common share for 2021 totaled $3.81 compared to $2.74 for 2020.

As of December 31, 2021, total assets equaled $15.5 billion, an increase of $1.4 billion, or 9.9 percent, from December 31, 2020. The Corporation experienced organic loan growth of $566.4 million, or 6.6 percent during 2021. This was offset by SBA forgiveness of PPP loans of $560.5 million, resulting in net loan growth of $5.9 million from December 31, 2020. At December 31, 2021, the Corporation's PPP loan portfolio, primarily included in the commercial and industrial loan class, totaled $106.6 million, a decrease of $560.5 million from the December 31, 2020 balance of $667.1 million.

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The largest loan classes that experienced increases from December 31, 2020 were public finance and other commercial loans, real estate construction loans and commercial real estate (owner occupied) loans. As noted above, PPP loans, which are primarily included in the commercial and industrial loan class, decreased $560.5 million from December 31, 2020, and when coupled with organic commercial and industrial loan growth of $498.4 million, the net decrease in the commercial and industrial loan class was $62.1 million. Other loan classes that experienced significant decreases from December 31, 2020 were commercial real estate (non-owner occupied) loans, residential real estate loans and agricultural land, production and other loans to farmers. Additional details of the changes in the Corporation's loan portfolio are discussed within NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, and the "LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.

Total investment securities increased $1.4 billion, or 43.8 percent, from December 31, 2020. The Corporation purchased investment securities by utilizing excess liquidity from deposit growth, which was held in interest-bearing deposits and cash and cash equivalents, in addition to liquidity from SBA forgiveness of PPP loans. Additional details of the Corporation's investment securities portfolio are discussed within NOTE 4. INVESTMENT SECURITIES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The Corporation’s allowance for credit losses - loans totaled $195.4 million as of December 31, 2021 and equaled 2.11 percent of total loans. The Corporation adopted the current expected credit losses ("CECL") model for calculating the allowance for credit losses on January 1, 2021. CECL replaces the previous "incurred loss" model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an "expected loss" model for measuring credit losses, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The new CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance sheet credit exposures based on historical experiences, current conditions, and reasonable and supportable forecasts. CECL also requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as credit quality and underwriting standards of an organization's portfolio. The impact of the adoption was an increase to the Allowance for Credit Losses - Loans of $74.1 million. Additional details of the Allowance methodology are discussed within NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The Corporation did not recognize any provision expense during the year ended December 31, 2021, compared to provision expense of $58.7 million for the year ended 2020. The provision expense taken in 2020 primarily reflected the Corporation's view of increased credit risk related to the COVID-19 pandemic. The Corporation recognized net charge-offs during 2021 of $9.3 million, compared to $8.3 million in 2020. Non-accrual loans totaled $43.1 million, a decrease of $18.4 million from December 31, 2020, resulting in a coverage ratio of 453.8 percent. Additional details of the Corporation's credit quality are discussed within the “LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

In 2020, the Corporation announced a banking delivery transformation strategy, which included the consolidation of seventeen banking centers across its footprint by April 30, 2021. As those consolidations finalized in the second quarter of 2021, the fair value of the closed banking centers of $4.5 million was moved from premises and equipment to assets held for sale (recorded in other assets) while they are marketed for sale.

The Corporation’s tax asset, deferred and receivable increased from $12.3 million at December 31, 2020 to $35.6 million at December 31, 2021. The Corporation’s net deferred tax asset increased from $4.3 million at December 31, 2020 to $24.3 million at December 31, 2021. The $20.0 million increase in the Corporation’s net deferred tax asset was due to a combination of an increase in deferred tax assets and a decrease in deferred tax liabilities. The largest deferred tax asset increases were associated with the tax effect of the implementation and accounting for CECL of $21.1 million and accounting for unrealized gains and losses on available for sale securities of $7.5 million. Offsetting the increases to the net deferred tax asset were net deferred tax decreases associated with accounting for loan fees and accounting for pensions and employee benefits of $2.3 million and $3.3 million, respectively.

The Corporation's other assets decreased $5.9 million from December 31, 2020. The Corporation's derivative asset (recorded in other assets) and derivative liability (recorded in other liabilities) related to interest rate contracts decreased $33.2 million and $34.4 million, respectively, from December 31, 2020. The decreases in valuations are due to higher yield curve rates across the entire term point spectrum. The higher interest rates are the result of higher inflation expectations, current increases in short-term rate trajectories, Federal Reserve tapering and increases in term premiums. Offsetting the decrease in the Corporation's derivative asset was an increase in the Corporation's prepaid pension of $12.1 million and investments in community redevelopment funds of $7.4 million.

As of December 31, 2021, total deposits equaled $12.7 billion, an increase of $1.4 billion from December 31, 2020. The Corporation experienced increases from December 31, 2020 in demand and savings accounts of $883.0 million and $673.1 million, respectively. A portion of the increase is due to PPP loans that have remained on deposit, in addition to consumer Economic Impact Payments from the IRS that have also remained on deposit. Offsetting these increases were decreases in certificates of deposit and brokered deposits of $142.2 million and $42.9 million, respectively, from December 31, 2020. The low interest rate environment has resulted in customers moving funds from maturing time deposit products into non-maturity products due to similar rates offered for both products.

Total borrowings decreased $50.7 million as of December 31, 2021, compared to December 31, 2020. Federal Home Loan Bank advances decreased $55.4 million compared to December 31, 2020 as the Corporation utilized excess liquidity from deposit growth to pay off maturing advances. Additionally, securities sold under repurchase agreements increased by $4.5 million.

The Corporation's other liabilities as of December 31, 2021 increased $29.2 million compared to December 31, 2020. As part of the CECL adoption on January 1, 2021, the Corporation recorded a $20.5 million allowance for credit losses on off-balance sheet credit exposures as a liability account. This amount represents expected credit losses over the contractual period for which the Corporation is exposed to credit risk resulting from a contractual obligation to extend credit. The Corporation also accrued $46.1 million of trade date accounting related to loan and investment securities purchases as of December 31, 2021, of which, the accrual was $6.2 million as of December 31, 2020. Additionally, as noted above, the derivative hedge liability decreased $34.4 million from December 31, 2020.

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The Corporation continued to maintain all regulatory capital ratios in excess of the regulatory definition of “well-capitalized.” Details of the Corporation's stock repurchase program and regulatory capital ratios are discussed within the “CAPITAL” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

RESULTS OF OPERATIONS - 2020

Net income available to stockholders for the year ended December 31, 2020 was $148.6 million compared to $164.5 million during the same period in 2019. Earnings per fully diluted common share for 2020 totaled $2.74 compared to $3.19 during the same period in 2019.

As of December 31, 2020, total assets equaled $14.1 billion, an increase of $1.6 billion, or 12.9 percent, from December 31, 2019. The Corporation's total loan portfolio increased $778.8 million, or 9.2 percent from December 31, 2019. At December 31, 2020, the Corporation's PPP loan portfolio totaled $667.1 million, net of $12.5 million of deferred processing fee income and costs, which were primarily included in the commercial and industrial loan class. Other loan segments that experienced large increases from December 31, 2019 were commercial real estate, non-owner occupied and public finance and other commercial loans. The largest loan segments that experienced a decrease were real estate construction and home equity loans. Additional details of the changes in the Corporation's loans are discussed within NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, and the "LOAN QUALITY" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.

Interest-bearing deposits increased $274.0 million from December 31, 2019 due to excess liquidity from deposit growth and an increase in wholesale funding. Additionally, total investment securities increased $550.7 million, or 21.2 percent, from December 31, 2019 as a portion of the excess liquidity from deposit growth and additional wholesale funding was used to invest in the bond portfolio. Also contributing to the increase in investment securities was a $62.1 million increase in net unrealized gains on the available for sale portfolio. The net increase in unrealized gains from December 31, 2019 to December 31, 2020 is primarily due to interest rate declines in 2020 as the longer term points on the yield curve have declined since year-end, which increases the fair value of securities in the portfolio. Additional details of the changes in the Corporation's investment securities portfolio are discussed within NOTE 4. INVESTMENT SECURITIES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The Corporation’s allowance for loan losses totaled $130.6 million as of December 31, 2020 and equaled 1.41 percent of total loans. For the year ended December 31, 2020, the Corporation's provision expense and net charge-offs were $58.7 million and $8.3 million, respectively, compared to provision expense and net charge-offs of $2.8 million and $3.1 million during the same period in 2019. For the year ended December 31, 2020, there were charge-offs greater than $500,000 on two commercial relationships, which totaled $7.3 million. The largest of the two charge-offs was $6.7 million for a university apparel relationship. For the same period in 2019, there were two commercial charge-offs greater than $500,000 which totaled $3.6 million. The increase in the allowance for loan losses and provision expense primarily reflects our view of increased credit risk related to the COVID-19 pandemic. Additional details of the changes in the Corporation's allowance for loan losses are discussed within NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, and the "PROVISION EXPENSE AND ALLOWANCE FOR CREDIT LOSSES ON LOANS" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.

Accounting Standards Update No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit losses on Financial Instruments ("CECL") had an original adoption date of January 1, 2020, which included a day 1 measurement date of January 1, 2020. The CARES Act, passed by Congress on March 27, 2020 in response to the COVID-19 pandemic, created an optional deferral of the CECL adoption date. Pursuant to the CARES Act and the related joint statement of federal banking regulators (which also became effective as of March 27, 2020), and consistent with guidance from the SEC and FASB, the Corporation elected to delay implementation of ASU No. 2016-13. The 2021 Consolidated Appropriations Act, signed into law on December 27, 2020, provided the annual funding for the federal government and also contained several rules giving further COVID-19 relief, one of which was an extension of the adoption date for CECL to the earlier of January 1, 2022 or the first day of the fiscal year that begins after the termination of the national emergency. The Corporation elected to adopt CECL on January 1, 2021 with a day one measurement date of January 1, 2021. As a result of the Corporation’s election, its 2020 financial statements have been prepared under the existing incurred loss model.

Non-accrual loans totaled $61.5 million at December 31, 2020, an increase of $45.6 million from the December 31, 2019 balance of $15.9 million. The increase in non-accrual loan balances during 2020 was primarily due to four non-owner occupied commercial real estate properties, in the senior and assisted living industry, moving to non-accrual. The total reported balance of these four loans was $40.0 million. Additional details of the Allowance for Loan Losses and non-performing loans are discussed within the “LOAN QUALITY" and "PROVISION EXPENSE AND ALLOWANCE FOR CREDIT LOSSES ON LOANS” sections of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The Corporation's other assets increased $45.9 million from December 31, 2019. The Corporation's derivative asset (recorded in other assets) and derivative liability (recorded in other liabilities) relating to interest rate contracts increased $46.5 million and $47.1 million, respectively, from December 31, 2019. The increases are primarily due to a $292.7 million increase in the related outstanding notional balance. Additionally, yield curve rates used for valuation purposes were lower at each term point as of December 31, 2020 compared to December 31, 2019. This was primarily the result of investors seeking the safety of U.S. Treasuries, coupled with Federal Reserve purchases of U.S. Treasuries, as containment efforts related to the COVID-19 outbreak began to significantly reduce economic activity.

As of December 31, 2020, total deposits equaled $11.4 billion, an increase of $1.5 billion, or 15.5 percent, from December 31, 2019. The Corporation experienced increases from December 31, 2019 in demand and savings accounts of $1.6 billion and $765.5 million, respectively. A portion of the increase is due to PPP loans that have remained on deposit, in addition to consumer Economic Impact Payments from the IRS that have also remained on deposit. Offsetting these increases were decreases in certificates of deposit and brokered deposits of $673.2 million and $141.2 million, respectively, from December 31, 2019. The low interest rate environment has resulted in customers migrating funds from maturing time deposit products into non-maturity products due to similar rates offered for both products.

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Total borrowings decreased $47.8 million as of December 31, 2020, compared to December 31, 2019. The Corporation's Federal Funds purchased decreased $55 million from December 31, 2019. The excess liquidity generated from deposit growth reduced the Corporation's need for overnight funding. Additionally, subordinated debentures and term loans decreased $20.3 million as the Corporation redeemed $20.0 million of subordinated debentures. Of the redemptions, $10.0 million was for a partial redemption of debentures held by First Merchants Capital Trust II (“FMC Trust II”) and the remaining $10.0 million was for a complete redemption of debentures held by Grabill Capital Trust I ("Grabill Trust"). Both FMC Trust II and Grabill Trust used the proceeds from the redemptions to concurrently redeem like amounts of their capital (preferred) securities, each with an aggregate principal redemption price of $10.0 million. The common securities of FMC Trust II are, and the common securities of Grabill Trust were, held by the Corporation (recorded in other assets). Subsequent to the redemption of its capital securities, Grabill Trust was dissolved. Offsetting these decreases, Federal Home Loan Bank advances increased $38.4 million compared to December 31, 2019. The Corporation took advantage of the low interest rate environment to lock in longer term FHLB advances at low rates.

The Corporation's other liabilities as of December 31, 2020 increased $50.4 million compared to December 31, 2019. As noted above, the derivative hedge liability increased $47.1 million from December 31, 2019. Additionally, the Corporation accrued $6.2 million of trade date accounting related to investment securities purchases as of December 31, 2020, of which, there was no accrual at December 31, 2019.

The Corporation was able to maintain all regulatory capital ratios in excess of the regulatory definition of “well-capitalized.” Details of the Stock Repurchase Programs and regulatory capital ratios are discussed within the “CAPITAL” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

NET INTEREST INCOME

Net interest income is the most significant component of the Corporation's earnings, comprising 79.0 percent of revenues for the year ended December 31, 2021. Net interest income and margin are influenced by many factors, primarily the volume and mix of earning assets, funding sources, and interest rate fluctuations. Other factors include the level of accretion income on purchased loans, prepayment risk on mortgage and investment-related assets, and the composition and maturity of earning assets and interest-bearing liabilities. Loans typically generate more interest income than investment securities with similar maturities. Funding from customer deposits generally costs less than wholesale funding sources. Factors such as general economic activity, Federal Reserve Board monetary policy, and price volatility of competing alternative investments, can also exert significant influence on our ability to optimize the mix of assets and funding and the net interest income and margin.

Net interest income is the excess of interest received from earning assets over interest paid on interest-bearing liabilities. For analytical purposes, net interest income is also presented on an FTE basis in the table that follows to reflect what our tax-exempt assets would need to yield in order to achieve the same after-tax yield as a taxable asset. The federal statutory rate of 21 percent was used for 2021, 2020, and 2019, adjusted for the TEFRA interest disallowance applicable to certain tax-exempt obligations. The FTE analysis portrays the income tax benefits associated with tax-exempt assets and helps to facilitate a comparison between taxable and tax-exempt assets. Management believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully taxable equivalent basis. Therefore, management believes these measures provide useful information for both management and investors by allowing them to make peer comparisons.

Net interest margin, on a tax equivalent basis, decreased 11 basis points to 3.18 percent for 2021 compared to 3.29 percent in 2020. For the year ended December 31, 2021, the increase in average earning assets of $1.5 billion was primarily attributable to an increase in investment securities of $1.1 billion. Additionally, since the beginning of the PPP in April 2020, the Bank originated over $1.2 billion of PPP loans which averaged $433.7 million in 2021 and $601.8 million in 2020. The Corporation's organic loan growth offset the decline in PPP loans and resulted in an increase in average loans of $119.5 million. The liquidity generated from the SBA forgiveness of PPP loans, coupled with excess liquidity generated from deposit growth, resulted in the Corporation's utilization of the liquidity for organic loan growth and investment securities purchases.

Asset yields decreased 40 basis points FTE in 2021 compared to 2020. This decrease was primarily a result of the FOMC's interest rate decreases of 50 basis points on March 3, 2020 and 100 basis points on March 16, 2020 at the Committee's special meetings related to COVID-19. Additionally, one-month LIBOR also saw a significant decline from January 1, 2020 of 1.73 percent to December 31, 2021 of 0.10 percent. The yield of the investment portfolio decreased 28 basis points compared to the same period in 2020 as the current year purchases had a lower yield than the historic yield of the portfolio. The loan portfolio, which generally has an average yield higher than the investment portfolio, was 67.5 percent of earning assets in 2021 compared to 74.7 percent in 2020. Average investment securities were 28.4 percent of total earning assets compared to 22.5 percent in 2020. The PPP loans originated in 2021 and 2020 were recorded at an interest rate of only 1 percent, but the Corporation also recognized fee income of $26.5 million in 2021, compared to $16.2 million in 2020, which is included in interest income.

The Corporation also recognized fair value accretion income on purchased loans, which is included in interest income, of $7.3 million, which accounted for 5 basis points of net interest margin for the year ended December 31, 2021. Comparatively, the Corporation recognized $13.5 million of fair value accretion income, which accounted for 11 basis points of net interest margin for the year ended December 31, 2020.

Interest costs decreased 35 basis points, which mitigated a majority of the decrease in asset yields and resulted in only a 5 basis point FTE decrease in net interest spread as compared to the same period in 2020. Interest costs have decreased as management aggressively moved deposit rates down as wholesale funding rates declined and market conditions allowed. Interest-bearing deposits and borrowing costs for the twelve months ended December 31, 2021 were 0.24 percent and 1.97 percent, respectively, compared to 0.60 percent and 1.91 percent, respectively, during the same period in 2020. Average borrowings decreased $128 million from 2020 as excess liquidity was used to payoff maturing FHLB advances. Average non-interest bearing deposits increased $448.2 million and equated to 20.7 percent of total deposits, compared to 19.3 percent in 2020. This increase, combined with the decrease in interest rates on interest-bearing deposits and debt repayments, resulted in a total cost of funds of 35 basis points compared to 70 basis points in 2020.

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In 2020, the increases in net interest income and average earning assets were primarily attributable to an increase in loans and investment securities portfolio. Asset yields decreased 94 basis point FTE and interest costs decreased 67 basis points, resulting in a 27 basis point FTE decrease in net interest spread as compared to 2019. The decrease in asset yields was primarily a result of the FOMC's interest rate decreases of 50 basis points on March 3, 2020 and 100 basis points on March 16, 2020 at the Committee's special meetings related to COVID-19, and the decline in one-month LIBOR from December 31, 2019 to December 31, 2020 of 162 basis points. The PPP loans originated in 2020 were recorded at an interest rate of only 1 percent, but the Corporation also recognized fee income of $16.2 million during 2020, which is included in interest income and had a positive impact to net interest margin of 2 basis points for 2020.

Average earning assets increased 2.1 billion in 2020 compared to 2019 primarily due to the September 1, 2019 MBT acquisition being included in the 2020 average balances for an entire year compared to only four months in 2019. Additionally, the Bank originated over $900 million of PPP loans which averaged $601.8 million for the year. The increase in the investment securities portfolio was the result of excess liquidity generated from growth in deposits and wholesale funding being used to invest in the bond portfolio. The Corporation also recognized fair value accretion income on purchased loans, which is included in interest income, of $13.5 million, which accounted for 11 basis points of net interest margin for the year ended December 31, 2020. Comparatively, the Corporation recognized $12.0 million of fair value accretion income, which accounted for 12 basis points of net interest margin for the year ended December 31, 2019.

Net interest margin is a function of net interest income and the level of average earning assets. The following table presents the Corporation’s interest income, interest expense, and net interest income as a percent of average earning assets for the three-year period ending in 2021.

Assets:

Investment Securities: (1)

Loans: (3)

Liabilities:

Interest-bearing deposits:

Net Interest Margin (FTE):

Interest Income (FTE) / Average Earning Assets 3.44 % 3.84 % 4.78 %

Interest Expense / Average Earning Assets 0.26 % 0.55 % 1.09 %

(1) Average balance of securities is computed based on the average of the historical amortized cost balances without the effects of the fair value adjustment. Annualized amounts are computed using a 30/360 day basis.

(2) Tax-exempt securities and loans are presented on a fully taxable equivalent basis, using a marginal tax rate of 21 percent for 2021, 2020 and 2019. These totals equal $20,585, $16,966 and $13,085, respectively.

(3) Non-accruing loans have been included in the average balances.

(4) Net Interest Spread (FTE) is interest income expressed as a percentage of average earning assets minus interest expense expressed as a percentage of average interest-bearing liabilities.

(5) Net Interest Margin (FTE) is interest income expressed as a percentage of average earning assets minus interest expense expressed as a percentage of average earning assets.

(6) Commercial loans included $106.6 million and $667.1 million of Paycheck Protection Program ("PPP") loans at December 31, 2021 and 2020, respectively.

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NON-INTEREST INCOME

Non-interest income totaled $109.3 million in 2021, a decrease of $0.6 million, or 0.5 percent, from 2020. Customer related fees increased $2.6 million in 2021 compared to 2020 with the largest increase of $4.6 million attributable to fiduciary and wealth management fees of which $3.6 million was organic growth and $1.0 million resulted from the acquisition of Hoosier Trust Company. Details of the Hoosier Trust Company acquisition can be found in NOTE 2. ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Additionally, service charges on deposit accounts increased $2.6 million due to both continued organic growth in the deposit customer base and a lesser impact from the COVID-19 pandemic on customer activity than in 2020. Finally, net gains and fees on sales of loans increased $1.4 million during 2021 as volume remained strong and was enhanced by a gain of $2.9 million from a $76.1 million portfolio mortgage loan sale.

The largest offsetting decreases in customer related fees, when comparing 2021 to 2020, were a $3.1 million decline in derivative hedge fees, and a $2.9 million decline in card payment fees that resulted from the first full year impact of the Durbin Amendment to the Dodd-Frank Act, which became effective for the Bank on July 1, 2020.

The largest non-customer related increase in non-interest income, when comparing 2021 to 2020, was a $2.1 million increase in gains on life insurance benefits resulting from BOLI death benefits. Finally, the largest non-customer related decrease was $6.2 million less net realized gains on sales of available for sale securities in 2021 than 2020.

Non-interest income totaled $109.9 million in 2020, an increase of $23.2 million, or 26.8 percent, over 2019. The low mortgage interest rate environment and larger customer base resulting from the MBT acquisition on September 1, 2019 combined to produce an increase of $10.4 million in net gains and fees on sales of loans. Additionally, the larger customer base from the MBT acquisition, in addition to organic growth, resulted in increases in fiduciary and wealth management fees and derivative hedge fees totaling $6.2 million and $1.6 million, respectively. Finally, net realized gains on the sale of available for sale securities increased $7.5 million when compared to 2019.

These increases were partially offset by a decrease in service charges on deposit accounts of $2.0 million mainly due to higher than normal customer deposit balances as a result of stimulus funds received in response to the COVID-19 pandemic. This resulted in significantly lower non-sufficient funds and overdraft fees when compared to 2019. Additionally, card payment fee income decreased $0.7 million when compared to 2019. While the larger customer base resulting from the MBT acquisition and organic growth resulted in increased transaction volume, the cap placed on interchange fee income as a result of the Durbin Amendment to the Dodd-Frank Act became effective for the Bank July 1, 2020 and resulted in less interchange revenue.

NON-INTEREST EXPENSES

Non-interest expense totaled $279.2 million in 2021, an increase of $15.8 million, or 6.0 percent, over 2020. The largest contributing factor was an $11.1 million increase in salaries and employee benefits primarily due to higher salary and incentive expenses based upon current year financial results along with higher employee benefit costs primarily from rising health insurance costs.

Additionally, other outside data processing fees increased $3.9 million in 2021, when compared to 2020, primarily due to increased loan processing expense and digital platform delivery expenses in 2021, primarily due to the deployment of online account origination technology. Also, the Corporation recorded reduced expense in 2020 from the sunsetting of a debit rewards program. Also, professional and other outside services increased $3.0 million in 2021 as projects that were delayed in 2020 due to the onset of the COVID-19 pandemic were resumed. The Corporation also recorded $0.5 million of expense directly related to the pending Level One Bancorp, Inc. merger. Details of the merger can be found in NOTE 2. ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Finally, other expenses increased $1.3 million primarily due to a $1.4 million increase in amortization of mortgage servicing rights as the mortgage servicing portfolio increased in 2021 as a result of the $76.1 million portfolio mortgage loan sale and an increase in held for sale loans being sold with servicing rights retained.

Offsetting the increases detailed above was a decline of $3.4 million in 2021 from 2020 in net occupancy. The decline was primarily driven by elevated expense in 2020, which included a charge of $3.8 million in net occupancy related to the consolidation of seventeen banking centers.

Non-interest expense totaled $263.4 million in 2020, an increase of $16.6 million, or 6.7 percent, over 2019. The increase was driven by 2020 having a full-year of expense from the larger franchise and growth in customer base resulting from the MBT acquisition when compared to 2019 only containing four months of activity. While the Corporation experienced increases in several non-interest expense categories the largest increase was in salaries and employee benefits which increased by $11.9 million compared to 2019. Net occupancy and equipment expenses reflected increases of $7.2 million and $3.1 million, respectively. In addition to the full-year impact of the larger franchise, the Corporation recorded $4.5 million of expenses in these two categories related to the recent announcement of the consolidation of seventeen banking centers.

Additionally, FDIC assessment expense increased $5.1 million in 2020, when compared to 2019, due to a combination of 2019 reflecting assessment credits issued as a result of the FDIC insurance fund reaching the FDIC's target minimum reserve ratio coupled with increased expense in the current year resulting from the Corporation's FDIC assessment changing to the calculation applicable to banks over $10 billion in total assets. Finally, the Corporation incurred $2.5 million of additional expense in 2020, compared to 2019, related to actions taken in response to the COVID-19 pandemic which included approximately $1.5 million in net occupancy and equipment costs incurred to enhance social distancing and cleaning protocols and $1.0 million recorded in marketing expense for donations to non-profit organizations in our communities on the front lines of the COVID-19 pandemic efforts.

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The increases noted above were partially offset by the Corporation having recorded $13.7 million of acquisition-related expenses in 2019 in connection with MBT, primarily consisting of $5.3 million of contract termination and core system conversion expenses, $5.2 million of employee severance and retention expenses and $1.6 million of professional and other outside services expense. Additionally, the decrease in outside data processing fees of $2.0 million in 2020, compared to 2019, is mainly related to the sunsetting of a debit rewards program. Finally, the Corporation also realized a decrease in other real estate owned and foreclosure expenses of $2.1 million when compared to 2019.

INCOME TAX EXPENSE

Income tax expense in 2021 was $35.3 million on pre-tax income of $240.8 million, or 14.6 percent. For 2020, income tax expense was $21.4 million on pre-tax income of $170.0 million, or 12.6 percent. The lower effective income tax rate in 2020 compared to 2021 was primarily driven by two factors. The first factor was an abnormally high level of loan provision expense in 2020 as a result of the economic impact of the COVID-19 pandemic. Second, the CARES Act from 2020 provided for the carryback of certain federal net operating losses to a prior period with a rate differential between the 2020 statutory rate of 21 percent and the rate in effect during the carryback year. Additionally, an increase in state taxes in 2021 contributed to the increase in the effective tax rate. The detailed reconciliation of federal statutory to actual tax expense is shown in NOTE 19. INCOME TAX of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Additional income tax expense details are discussed within the “INCOME TAXES” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations. .

CAPITAL

Stockholders' Equity

As discussed previously, the Corporation adopted the current expected credit losses ("CECL") model for calculating the allowance for credit losses on January 1, 2021. CECL replaces the previous "incurred loss" model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an "expected loss" model for measuring credit losses, which encompasses allowances for losses expected to be incurred over the life of the portfolio. As of the adoption and day one measurement date of January 1, 2021, the Corporation recorded a one-time cumulative-effect adjustment to retained earnings, net of income taxes, of $68.0 million. See additional details of the Corporation's CECL adoption in NOTE 1. NATURE OF OPERATIONS AND SUMMARY OR SIGNIFICANT ACCOUNTING POLICIES and NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Stock Repurchase Programs

On September 3, 2019, the Board of Directors of the Corporation approved a stock repurchase program of up to 3 million shares of the Corporation's outstanding common stock; provided, however, that the total aggregate investment in shares repurchased under the program was not to exceed $75 million. On a share basis, the amount of common stock subject to the repurchase program represented approximately 5 percent of the Corporation's outstanding shares. During the first quarter of 2020, the Corporation repurchased 1,634,437 of its common shares for $55.9 million at an average price of $34.21, which resulted in the aggregate investment in share repurchases of $75.0 million, the maximum allowable under the plan. As such, the September 2019 program terminated upon its own terms following the repurchases.

On January 27, 2021, the Board of Directors of the Corporation approved a stock repurchase program of up to 3,333,000 shares of the Corporation's outstanding common stock; provided, however, that the total aggregate investment in shares repurchased under the program may not exceed $100,000,000. On a share basis, the amount of common stock subject to the repurchase program represents approximately 6 percent of the Corporation's outstanding shares. During 2021, the Corporation repurchased 646,102 of its common shares for $25.4 million at an average price of $39.38.

Regulatory Capital

Capital adequacy is an important indicator of financial stability and performance. The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies and are assigned to a capital category. The assigned capital category is largely determined by four ratios that are calculated according to the regulations: total risk-based capital, tier 1 risk-based capital, CET1, and tier 1 leverage ratios. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures of the entity. The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios.

There are five capital categories defined in the regulations, ranging from well capitalized to critically undercapitalized. Classification of a bank in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank's operations. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets, or leverage ratio, all of which are calculated as defined in the

regulations. Banks with lower capital levels are deemed to be undercapitalized, significantly undercapitalized or critically undercapitalized, depending on their actual levels. The appropriate federal regulatory agency may also downgrade a bank to the next lower capital category upon a determination that the bank is in an unsafe or unsound practice. Banks are required to monitor closely their capital levels and to notify their appropriate regulatory agency of any basis for a change in capital category.

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Basel III was effective for the Corporation on January 1, 2015 and requires the Corporation and the Bank to maintain the minimum capital and

leverage ratios as defined in the regulation and as illustrated in the table below, which capital to risk-weighted asset ratios include a 2.5 percent capital conservation buffer. Under Basel III, in order to avoid limitations on capital distributions, including dividends, the Corporation must hold a 2.5 percent capital conservation buffer above the adequately capitalized CET1 to risk-weighted assets ratio (which buffer is reflected in the required ratios below). Under Basel III, the Corporation and Bank elected to opt-out of including accumulated other comprehensive income in regulatory capital. As of December 31, 2021, the Bank met all capital adequacy requirements to be considered well capitalized under the fully phased-in Basel III capital rules. There is no threshold for well capitalized status for bank holding companies.

As part of a March 27, 2020 joint statement of federal banking regulators, an interim final rule that allowed banking organizations to mitigate the effects of the CECL accounting standard on their regulatory capital was announced. Banking organizations could elect to mitigate the estimated cumulative regulatory capital effects of CECL for up to two years. This two-year delay was to be in addition to the three-year transition period that federal banking regulators had already made available. While the 2021 CAA provided for a further extension of the mandatory adoption of CECL until January 1, 2022, the federal banking regulators elected to not provide a similar extension to the two year mitigation period applicable to regulatory capital effects. Instead, the federal banking regulators require that, in order to utilize the additional two-year delay, banking organizations must have adopted the CECL standard no later than December 31, 2020, as required by the CARES Act. As a result, because implementation of the CECL standard was delayed by the Corporation until January 1, 2021, it began phasing in the cumulative effect of the adoption on its regulatory capital, at a rate of 25 percent per year, over a three-year transition period that began on January 1, 2021. Under that phase-in schedule, the cumulative effect of the adoption will be fully reflected in regulatory capital on January 1, 2024.

The Corporation's and Bank's actual and required capital ratios as of December 31, 2021 and December 31, 2020 were as follows:

Prompt Corrective Action Thresholds

Actual Basel III Minimum Capital Required Well Capitalized

December 31, 2021 Amount Ratio Amount Ratio Amount Ratio

Total risk-based capital to risk-weighted assets

Tier 1 capital to risk-weighted assets

Common equity tier 1 capital to risk-weighted assets

Tier 1 capital to average assets

Prompt Corrective Action Thresholds

Actual Basel III Minimum Capital Required Well Capitalized

December 31, 2020 Amount Ratio Amount Ratio Amount Ratio

Total risk-based capital to risk-weighted assets

Tier 1 capital to risk-weighted assets

Common equity tier 1 capital to risk-weighted assets

Tier 1 capital to average assets

On April 9, 2020, federal banking regulators issued an interim final rule to modify the Basel III regulatory capital rules applicable to banking

organizations to allow those organizations participating in the PPP to neutralize the regulatory capital effects of participating in the program. The

interim final rule, which became effective April 13, 2020, clarified that PPP loans receive a zero percent risk weight for purposes of determining

risk-weighted assets and the CET1, Tier 1 and Total Risk-Based capital ratios. At December 31, 2021 and 2020, risk-weighted assets included $106.6 million and $667.1 million, respectively, of PPP loans at a zero risk weight.

Management believes that all of the above capital ratios are meaningful measurements for evaluating the safety and soundness of the Corporation. Traditionally, the banking regulators have assessed bank and bank holding company capital adequacy based on both the amount and the composition of capital, the calculation of which is prescribed in federal banking regulations. The Federal Reserve focuses its assessment of capital adequacy on a component of Tier 1 capital known as CET1. Because the Federal Reserve has long indicated that voting common shareholders' equity (essentially Tier 1 risk-based capital less preferred stock and non-controlling interest in subsidiaries) generally should be the dominant element in Tier 1 risk-based capital, this focus on CET1 is consistent with existing capital adequacy categories. Tier I regulatory capital consists primarily of total stockholders’ equity and subordinated debentures issued to business trusts categorized as qualifying borrowings, less non-qualifying intangible assets and unrealized net securities gains or losses.

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A reconciliation of GAAP measures to regulatory measures (non-GAAP) are detailed in the following table for the periods indicated.

Total Risk-Based Capital

Add: Qualifying Capital Securities 46,606 — 46,368 —

Add: Modified CECL Transition Amount 34,542 34,542 — —

Less: Disallowed Deferred Tax Assets (239) (219) — —

Qualifying Subordinated Debentures 65,000 — 65,000 —

Common Equity Tier 1 Capital Ratio

Less: Qualified Capital Securities (46,606) — (46,368) —

(1) Includes net unrealized gains or losses on available for sale securities, net gains or losses on cash flow hedges, and amounts resulting from the application of the applicable accounting guidance for defined benefit and other postretirement plans.

Additionally, management believes the following tables are also meaningful when considering performance measures of the Corporation. Non-

GAAP financial measures such as tangible common equity to tangible assets, return on average tangible capital and return on average tangible

assets are important measures of the strength of the Corporation's capital and ability to generate earnings on tangible common equity invested

by our shareholders. These non-GAAP measures provide useful supplemental information and may assist investors in analyzing the

Corporation’s financial position without regard to the effects of intangible assets and preferred stock. Disclosure of these measures also allows

analysts and banking regulators to assess our capital adequacy on these same bases.

Because these measures are not defined in GAAP or federal banking regulations, they are considered non-GAAP financial measures. Non-

GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although these non-GAAP

financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools, and should not be

considered in isolation, or as a substitute for analyses of results as reported under GAAP.

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The Corporation had a strong capital position as evidenced by the tangible common equity to tangible assets ratio of 9.01 percent at December 31, 2021, and 9.65 percent at December 31, 2020.

Tangible Common Equity to Tangible Assets (non-GAAP)

Less: Cumulative preferred stock (GAAP) (125) (125)

Stockholders' Equity to Assets (GAAP) 12.38 % 13.33 %

Tangible common equity to tangible assets (non-GAAP) 9.01 % 9.65 %

Plus: Tax Benefit of intangibles (non-GAAP) 4,875 5,989

Tangible book value - common (non-GAAP) $ 25.21 $ 24.27

The following table details and reconciles tangible earnings per share, return on tangible capital and tangible assets to traditional GAAP measures for the periods ended December 31, 2021 and 2020.

Average deferred tax on intangibles (GAAP) (5,452) (6,648)

Average cumulative preferred stock (GAAP) (125) (125)

Net income available to common stockholders (GAAP) $ 205,531 $ 148,600

Intangible amortization, net of tax (GAAP) 4,540 4,730

Per Share Data:

Diluted net income available to common stockholders (GAAP) $ 3.81 $ 2.74

Ratios:

Return on average capital (ROE) (GAAP) 11.01 % 8.14 %

Return on average tangible capital (non-GAAP) 16.17 % 12.21 %

Return on average assets (ROA) (GAAP) 1.39 % 1.10 %

Return on average tangible assets (non-GAAP) 1.47 % 1.19 %

Return on average tangible capital is tangible net income available to common stockholders (annualized) expressed as a percentage of average tangible capital. Return on average tangible assets is tangible net income available to common stockholders (annualized) expressed as a percentage of average tangible assets.

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LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS

The Corporation’s primary lending focus is small business and middle market commercial, commercial real estate, public finance and residential real estate, which results in portfolio diversification. Commercial loans are individually underwritten and judgmentally risk rated. They are periodically monitored and prompt corrective actions are taken on deteriorating loans. Consumer loans are typically underwritten with statistical decision-making tools and are managed throughout their life cycle on a portfolio basis.

Loan Quality

The quality of the loan portfolio and the amount of non-performing loans may increase or decrease as a result of acquisitions, organic portfolio growth, problem loan recognition and resolution through collections, sales or charge-offs. The performance of any loan can be affected by external factors such as economic conditions, or internal factors specific to a particular borrower, such as the actions of a customer's internal management.

At December 31, 2021, non-performing loans totaled $43.4 million, a decrease of $21.3 million from December 31, 2020. Loans not accruing interest income totaled $43.1 million at December 31, 2021, a decrease of $18.4 million from December 31, 2020. The decrease in non-accrual loans was primarily attributed to the payoff of one senior living sector relationship totaling $23.4 million.

Other real estate owned and repossessions, totaling $558,000 at December 31, 2021, decreased $382,000 from December 31, 2020. For other real estate owned, current appraisals are obtained to determine fair value as management continues to aggressively market these real estate assets.

According to applicable accounting guidance, loans that no longer exhibit similar risk characteristics are individually evaluated to determine if there is a need for a specific reserve. Commercial loans under $500,000 and consumer loans, with the exception of troubled debt restructures, are not individually evaluated. The determination for individual evaluation is made based on current information or events that may suggest it is probable that not all amounts due of principal and interest, according to the contractual terms of the loan agreement, will be substantially collected.

The Corporation's non-performing assets plus accruing loans 90 days or more delinquent and individually evaluated loans are presented in the table below.

Non-Performing Assets:

Loans 90-days or more delinquent and still accruing 963 746

The non-accrual balances in the table above include troubled debt loan restructures totaling $13.7 million and $1.7 million as of December 31, 2021 and December 31, 2020, respectively. The increase is primarily due to one relationship in the non-owner occupied commercial real estate loan class, totaling $12.5 million, that was restructured during 2021.

The composition of non-performing assets plus accruing loans 90-days or more delinquent is reflected in the following table.

Non-performing assets and loans 90-days or more delinquent:

Commercial and industrial loans $ 8,273 $ 2,923

Agricultural land, production and other loans to farmers 631 1,012

Real estate loans

Commercial real estate, non-owner occupied 23,125 47,548

Commercial real estate, owner occupied 432 3,040

Individual's loans for household and other personal expenditures 3 55

Public finance and other commercial loans — —

Non-performing assets and loans 90-days or more delinquent $ 44,912 $ 66,397

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The CARES Act, as amended by the 2021 CAA, allowed banks to suspend requirements under GAAP, effectively, through January 1, 2022, for certain loan modifications related to the COVID-19 pandemic. The federal banking agencies also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19 or offer other borrower friendly options. In accordance with such guidance, the Bank made various short-term modifications for borrowers who were current and otherwise not past due. These included short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that were insignificant. At December 31, 2021, the Corporation did not have any outstanding COVID modifications, compared to $120.3 million on 87 loans at December 31, 2020.

PROVISION EXPENSE AND ALLOWANCE FOR CREDIT LOSSES ON LOANS

The Corporation adopted FASB Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("CECL") on January 1, 2021. CECL replaces the previous "incurred loss" model with an "expected loss" model of measuring credit losses, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The new CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost based on historical experiences, current conditions and reasonable and supportable economic forecasts. CECL also requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as credit quality and underwriting standards of an organization's portfolio. Additional details of the Corporation's methodology for measuring expected credit losses on loans is discussed in NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The CECL allowance is maintained through the provision for credit losses, which is a charge against earnings. Based on management’s judgment as to the appropriate level of the allowance, the amount provided in any period may be greater or less than net loan losses for the same period. The determination of the provision amount and the adequacy of the allowance in any period is based on management’s continuing review and evaluation of the loan portfolio.

The Corporation's credit loss experience is presented in the table below for the years indicated.

Allowance for loan/credit losses:

Provision for loan/credit losses — 58,673 2,800

The Corporation’s total loan balance remained relatively level year over year ending December 31, 2021 at $9.2 billion. PPP loans accounted for $106.6 million of the total loan balance at December 31, 2021 versus a balance of $667.1 million at December 31, 2020. The Bank anticipates that the majority of its remaining PPP loans will be forgiven by the SBA in accordance with the terms of the program.

At December 31, 2021, the allowance for credit losses totaled $195.4 million, which represents an increase of $64.7 million from December 31, 2020. The increase in the allowance was primarily due to the $74.1 million cumulative effect adjustment related to the adoption of CECL on January 1, 2021, offset by net charge-offs during the twelve months ended December 31, 2021 of $9.3 million. As a percentage of loans, the allowance for credit losses was 2.11 percent at December 31, 2021, compared to 1.41 percent at December 31, 2020 and 0.95 percent at December 31, 2019. The allowance for credit losses as a percentage of total loans less PPP loans was 2.14 percent as of December 31, 2021.

The extent to which COVID-19 continues to impact the Corporation’s loan portfolio, will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and severity of the pandemic, the potential for seasonal or other resurgences, actions taken by governmental authorities and other third parties to contain and treat the virus, and how quickly and to what extent normal economic and operating conditions can resume. The Corporation deems the current estimate for loan portfolio credit exposure as appropriate.

There was no provision for credit losses for the twelve months ended December 31, 2021 compared to $58.7 million for the same period of 2020. The provision for the twelve months ended December 31, 2020 primarily reflected the Corporation's view of increased credit risk related to the COVID-19 pandemic and the estimated impact on the economy and the credit quality of our loan portfolio.

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Net charge-offs totaling $9.3 million, $8.3 million, and $3.1 million were recognized for the twelve months ended December 31, 2021, 2020, and 2019, respectively. For the twelve months ended December 31, 2021, there were four individual charge-offs greater than $500,000 that totaled $9.0 million. For the twelve months ended December 31, 2020, there were two individual charge-offs greater than $500,00 that totaled $7.3 million. For the twelve months ending December 31, 2021 and 2020, there were not any individual recoveries greater than $500,000. The distribution of the net charge-offs (recoveries) for the twelve months ended December 31, 2021, 2020, and 2019 are reflected in the following table.

Net charge-offs:

Agricultural land, production and other farm loans (60) (2) 2

Real estate loans

Commercial real estate, non-owner occupied 3,334 (148) 1,170

Commercial real estate, owner occupied 619 56 (2)

Individuals loans for household and other personal expenditures 349 383 168

Public finance and other commercial loans — — 239

Management continually evaluates the commercial loan portfolio by including consideration of specific borrower cash flow analysis and estimated collateral values, types and amounts on non-performing loans, past and anticipated credit loss experience, changes in the composition of the loan portfolio, and the current condition and amount of loans outstanding. The determination of the provision for credit losses in any period is based on management’s continuing review and evaluation of the loan portfolio, and its judgment as to the impact of current economic conditions on the portfolio.

GOODWILL

As of October 1, 2021, the Corporation performed its annual goodwill impairment testing and, in the valuation, the fair value exceeded the Corporation's carrying value; therefore, it was concluded that goodwill was not impaired. The Hoosier acquisition on April, 1, 2021 resulted in $1,467,000 of additional goodwill during the year. Details regarding the Hoosier acquisition are discussed in NOTE 2. ACQUISITIONS of these Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

As of October 1, 2020, the Corporation performed its annual goodwill impairment test which included various valuation considerations including comparable peer data, precedent transaction comparables, discounted cash flow analysis, overall financial performance, share price of the Corporation's common stock and other factors. The testing for 2020 resulted in a conclusion that it was not more likely than not that the fair value of the Corporation had declined below its carrying value and no impairment loss was recorded in 2020.

LIQUIDITY

Liquidity management is the process by which the Corporation ensures that adequate liquid funds are available for the holding company and its subsidiaries. These funds are necessary in order to meet financial commitments on a timely basis. These commitments include withdrawals by depositors, funding credit obligations to borrowers, paying dividends to stockholders, paying operating expenses, funding capital expenditures, and maintaining deposit reserve requirements. Liquidity is monitored and closely managed by the asset/liability committee.

The Corporation’s liquidity is dependent upon the receipt of dividends from the Bank, which is subject to certain regulatory limitations and access to other funding sources. Liquidity of the Bank is derived primarily from core deposit growth, principal payments received on loans, the sale and maturity of investment securities, net cash provided by operating activities, and access to other funding sources.

The principal source of asset-funded liquidity is investment securities classified as available for sale, the market values of which totaled $2.3 billion at December 31, 2021, an increase of $425.4 million, or 22.2 percent, from December 31, 2020. Securities classified as held to maturity that are maturing within a short period of time can also be a source of liquidity. Securities classified as held to maturity and that are maturing in one year or less totaled $7.0 million at December 31, 2021. In addition, other types of assets such as cash and interest-bearing deposits with other banks, federal funds sold and loans maturing within one year are sources of liquidity.

The most stable source of liability-funded liquidity for both the long-term and short-term is deposit growth and retention in the core deposit base. Federal funds purchased and securities sold under agreements to repurchase are also considered a source of liquidity. In addition, FHLB advances are utilized as a funding source. At December 31, 2021, total borrowings from the FHLB were $334.1 million. The Bank has pledged certain mortgage loans and investments to the FHLB. The total available remaining borrowing capacity from the FHLB at December 31, 2021 was $728.5 million.

The Corporation and the Bank receive outside credit ratings from Moody's. Both the Corporation and the Bank currently have Issuer Ratings of Baa1 with a Rating Outlook of Stable. Additionally, the Bank has a Baseline Credit Assessment Rating of a3. Management considers these ratings to be indications of a sound capital base and strong liquidity and believes that these ratings would help ensure the ready marketability of its commercial paper. Because of the Corporation's and Bank's current levels of long-term debt, management believes it could generate additional liquidity from various sources should the need arise.

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PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table presents the Corporation's material cash requirements from known contractual and other obligations at December 31, 2021:

Payments Due In

(Dollars in Thousands) One Year or Less Over One Year Total

Securities sold under repurchase agreements 181,577 — 181,577

For further details related to the Corporation's deposits and borrowings, see NOTE 10. DEPOSITS and NOTE 11. BORROWINGS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Also, in the normal course of business, the Bank is a party to a number of other off-balance sheet activities that contain credit, market and operational risk that are not reflected in whole or in part in the consolidated financial statements. These activities primarily consist of traditional off-balance sheet credit-related financial instruments such as loan commitments and standby letters of credit.

Summarized credit-related financial instruments at December 31, 2021 are as follows:

(Dollars in Thousands) December 31, 2021

Amounts of Commitments:

Loan commitments to extend credit $ 3,917,215

Standby letters of credit 34,613

Since many of the commitments are expected to expire unused or be only partially used, the total amount of unused commitments in the preceding table does not necessarily represent future cash requirements.

INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK

Asset/Liability management has been an important factor in the Corporation's ability to record consistent earnings growth through periods of interest rate volatility and product deregulation. Management and the Board of Directors monitor the Corporation's liquidity and interest sensitivity positions at regular meetings to review how changes in interest rates may affect earnings. Decisions regarding investment and the pricing of loan and deposit products are made after analysis of reports designed to measure liquidity, rate sensitivity, the Corporation’s exposure to changes in net interest income given various rate scenarios and the economic and competitive environments.

It is the objective of the Corporation to monitor and manage risk exposure to net interest income caused by changes in interest rates. It is the goal of the Corporation’s Asset/Liability management function to provide optimum and stable net interest income. To accomplish this, management uses two asset liability tools. GAP/Interest Rate Sensitivity Reports and Net Interest Income Simulation Modeling are constructed, presented and monitored quarterly. Management believes that the Corporation's liquidity and interest sensitivity position at December 31, 2021 remained adequate to meet the Corporation’s primary goal of achieving optimum interest margins while avoiding undue interest rate risk.

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PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table presents the Corporation’s interest rate sensitivity analysis as of December 31, 2021.

(Dollars in Thousands) 1-180 Days 181-365 Days 1-5 Years Beyond 5 Years Total

Rate-Sensitive Assets:

Rate-Sensitive Liabilities:

Securities sold under repurchase agreements 181,577 — — — 181,577

Cumulative rate sensitivity gap ratio

The Corporation had a cumulative negative gap of $3.7 billion in the one-year horizon at December 31, 2021, or 23.8 percent of total assets.

Net interest income simulation modeling, or earnings-at-risk, measures the sensitivity of net interest income to various interest rate movements. The Corporation's asset liability process monitors simulated net interest income under three separate interest rate scenarios; base, rising and falling. Estimated net interest income for each scenario is calculated over a twelve-month horizon. The immediate and parallel changes to the base case scenario used in the model are presented below. The interest rate scenarios are used for analytical purposes and do not necessarily represent management's view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may introduce into the earnings of the Corporation.

The base scenario is highly dependent on numerous assumptions embedded in the model, including assumptions related to future interest rates. While the base sensitivity analysis incorporates management's best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact will likely differ from that projected. For certain assets, the base simulation model captures the expected prepayment behavior under changing interest rate environments. Assumptions and methodologies regarding the interest rate or balance behavior of indeterminate maturity products, such as savings, money market, interest-bearing and demand deposits, reflect management's best estimate of expected future behavior. Historical retention rate assumptions are applied to non-maturity deposits for modeling purposes.

The comparative rising 200 basis points and falling 100 basis points scenarios below, as of December 31, 2021, assume further interest rate changes in addition to the base simulation discussed above. These changes are immediate and parallel changes to the base case scenario. In the current rate environment, many drivers are at or near historical lows due to the FOMC's rate reductions in March 2020 in response to COVID-19.

Results for rising 200 basis points and falling 100 basis points interest rate scenarios are listed below based upon the Corporation’s rate sensitive assets and liabilities at December 31, 2021. The change from the base case represents cumulative net interest income over a twelve-month time horizon. Balance sheet assumptions used for the base scenario are the same for the rising and falling simulations.

Rising 200 basis points from base case 1.4% 5.9 %

Falling 100 basis points from base case (0.9)% 0.7 %

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PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

EARNING ASSETS

The following table presents the earning asset mix as of December 31, 2021 and December 31, 2020. Earning assets increased by $1.5 billion, or 11.4 percent, during the twelve months ended December 31, 2021.

Deposit growth of $1.4 billion, coupled with proceeds from SBA forgiveness of PPP loans, generated excess liquidity. The Corporation primarily used the excess liquidity to purchase investment securities, which increased $1.4 billion from December 31, 2020. Additionally, a portion of the excess liquidity was held in interest bearing deposits, which increased $81.8 million from December 31, 2020. Additional details of the changes in the Corporation's investment securities portfolio are discussed within NOTE 4. INVESTMENT SECURITIES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The Corporation's total loan portfolio increased $5.9 million from December 31, 2020. At December 31, 2021, the Corporation's PPP loan portfolio, primarily in the commercial and industrial loan class, totaled $106.6 million, a decrease of $560.5 million from the December 31, 2020 balance of $667.1 million. The Corporation experienced organic loan growth of $566.4 million, or 6.6 percent during 2021, which when offset by the decline in PPP loans, resulted in net loan growth of $5.9 million.

The largest loan classes that experienced increases from December 31, 2020 were public funds and other commercial loans, real estate construction loans and commercial real estate (owner occupied) loans. The decline in PPP loans was offset by organic loan growth in the commercial and industrial loan class of $498.4 million, resulting in a net decrease in commercial and industrial. Other loan classes that experienced significant decreases from December 31, 2020 were commercial real estate (non-owner occupied) loans, residential real estate loans and agricultural land, production and other loans to farmers. Additional details of the changes in the Corporation's loan portfolio are discussed within NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, and the "LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.

December 31, December 31,

DEPOSITS AND BORROWINGS

The table below reflects the level of deposits and borrowed funds (repurchase agreements, FHLB advances, subordinated debentures and term loans) at December 31, 2021 and 2020.

December 31, December 31,

Deposits:

Deposits increased $1.4 billion from December 31, 2020. The Corporation experienced increases from December 31, 2020 in demand and savings deposits accounts of $883.0 million and $673.1 million, respectively. A portion of the increase is due to PPP loans that have remained on deposit, in addition to consumer Economic Impact Payments from the IRS that have also remained on deposit. Offsetting these increases were decreases in certificates of deposits and brokered deposits of $142.2 million and $42.9 million, respectively, from December 31, 2020. The low interest rate environment has resulted in customers migrating from maturing time deposit products into non-maturity products due to similar rates offered for both products.

Federal Home Loan Bank advances decreased $55.4 million compared to December 31, 2020 as the Corporation utilized excess liquidity from deposit growth to pay off maturing advances. The Corporation has leveraged its capital position with FHLB advances, as well as repurchase agreements, which are pledged against acquired investment securities as collateral for the borrowings. Further discussion regarding FHLB advances is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “LIQUIDITY”. Additionally, the interest rate risk is included as part of the Corporation’s interest simulation discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK”.

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PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INCOME TAXES

The Corporation’s federal statutory income tax rate for 2021 is 21 percent and its state tax rate varies from 0 to 9.5 percent depending on the state in which the subsidiary company operates. The Corporation’s effective tax rate, which was 14.6 percent in 2021 and 12.6 percent in 2020, is lower than the blended effective statutory federal and state rates primarily due to the Corporation’s income on tax-exempt securities and loans, income generated by the subsidiaries operating in a state with no state or local income tax, income tax credits generated from investments in affordable housing projects, and tax-exempt earnings from bank-owned life insurance contracts. The reconciliation of federal statutory to actual tax expense is shown in NOTE 19. INCOME TAX of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The Corporation’s tax asset, deferred and receivable increased from $12.3 million at December 31, 2020 to $35.6 million at December 31, 2021. The Corporation’s net deferred tax asset increased from $4.3 million at December 31, 2020 to $24.3 million at December 31, 2021. The $20.0 million increase in the Corporation’s net deferred tax asset was due to a combination of an increase in deferred tax assets and a decrease in deferred tax liabilities. The largest net deferred tax asset increases were associated with the tax effect of the implementation and accounting for CECL of $21.1 million and accounting for unrealized gains and losses on available for sale securities of $7.5 million. Offsetting the increases to the net deferred tax asset were net deferred tax decreases associated with accounting for loan fees and accounting for pensions and employee benefits of $2.3 million and $3.3 million respectively.

INFLATION

The Corporation’s financial statements are presented in accordance with GAAP, which requires the measurement of financial position and operating results primarily in terms of historic dollar values. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on the Corporation’s operations is reflected in increased operating costs. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond the Corporation’s control, including changes in the expected rate of inflation, the influence of general and local economic conditions and governmental monetary and fiscal policies. The Corporation's sensitivity to interest rate changes are presented in this Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK”.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The quantitative and qualitative disclosures about market risk information are presented in the “INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Report of Independent Registered Public Accounting Firm

To the Stockholders, Board of Directors and Audit Committee

First Merchants Corporation

Muncie, Indiana

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of First Merchants Corporation (the “Corporation”) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes (collectively referred to as the “financial statements”). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Corporation as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Corporation’s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 1, 2022, expressed an unqualified opinion.

Change in Accounting Principle

As discussed in Note 1 of the consolidated financial statements, the Corporation has changed its method of accounting for credit losses effective January 1, 2021 due to the adoption of Accounting Standards Topic 326: Financial Instruments - Credit Losses. The adoption of new credit loss standard and its subsequent application is also communicated as a critical audit matter.

Basis for Opinion

These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on the Corporation’s consolidated financial statements based on our audits.

We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Corporation in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.

Allowance for Credit Losses

As described in Note 5 to the consolidated financial statements, the Corporation’s allowance for credit losses (ACL) on loans was $195.4 million as of December 31, 2021. The ACL is an estimate of current expected credit losses in the loan portfolio. The determination of the ACL requires significant judgment reflecting the Corporation’s best estimate of expected future losses for the loan’s entire contractual term adjusted for expected payments when appropriate.

We identified the valuation of the ACL as a critical audit matter. Auditing the ACL involves a high degree of subjectivity in evaluating management’s estimates, such as evaluating management’s assessment of economic forecasts and conditions and other environmental factors used to adjust historical loss rates, evaluating the adequacy of specific allowances associated with loans individually evaluated and assessing the appropriateness of loan grades.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

How We Addressed the Matter in Our Audit

The primary procedures we performed to address this critical audit matter included:

•Obtained an understanding of the Corporation’s process for establishing the ACL, including the implementation of models and the qualitative factor adjustments of the ACL

•Testing the design and operating effectiveness of internal controls, including those related to technology, over the ACL, the establishment of qualitative adjustments for current and expected conditions, grading and risk classification of loans and establishment of specific reserves on individually evaluated loans and management’s review controls over the ACL balance as a whole including attending internal Corporation Credit Policy Committee meetings and Audit Committee discussions and analysis.

•Testing clerical and computational accuracy of the formulas within the calculation.

•Testing of completeness and accuracy of the information and reports utilized in the ACL, including reports used in management review controls over the ACL.

•Performed reviews of individual credit files to evaluate the reasonableness of loan credit risk ratings

•Tested internally prepared loan reviews to evaluate the reasonableness of loan credit risk ratings

•Evaluated the qualitative adjustments to the ACL including assessing the basis for adjustments and the reasonableness of the significant assumptions

•Evaluating the forecast adjustment, including assessing that it is reasonable and supportable

•Tested the reasonableness of specific reserves on individually reviewed loans

•Evaluated credit quality trends in delinquencies, non-accruals, charge-offs and loan risk ratings

•Evaluated the overall reasonableness of the ACL and evaluated trends identified within peer groups

•Identifying fields in the various loan systems that defined the loan pools and tested the design and operating effectiveness of internal controls surrounding the input and maintenance of those fields.

BKD, LLP

We have served as the Corporation’s auditor since at least 1982; however, an earlier year cannot be reliably determined.

Indianapolis, Indiana

March 1, 2022

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

December 31, December 31,

(Dollars in Thousands, Except Share Data) 2021 2020

ASSETS

Other real estate owned 558 940

LIABILITIES

Deposits:

Borrowings:

COMMITMENTS AND CONTINGENT LIABILITIES

STOCKHOLDERS' EQUITY

Cumulative Preferred Stock, $1,000 par value, $1,000 liquidation value:

Authorized - 600 shares

Common Stock, $0.125 stated value:

Accumulated other comprehensive income 55,113 74,836

1Beginning January 1, 2021, the amount is based on the current expected credit loss methodology. Prior to January 1, 2021, the amount is based on the incurred loss methodology. See additional details in NOTE 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES of these Notes to Consolidated Financial Statements.

See notes to consolidated financial statements.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF INCOME

INTEREST INCOME

Loans receivable:

Investment securities:

INTEREST EXPENSE

Securities sold under repurchase agreements 314 604 1,424

Provision for credit losses - loans — 58,673 2,800

OTHER INCOME

Increase in cash surrender value of life insurance 4,873 5,040 4,518

Net realized gains on sales of available for sale securities 5,674 11,895 4,415

OTHER EXPENSES

Other real estate owned and foreclosure expenses 992 330 2,428

NET INCOME AVAILABLE TO COMMON STOCKHOLDERS PER SHARE DATA:

See notes to consolidated financial statements.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Other comprehensive income (loss):

Unrealized gains/losses on securities available-for-sale:

Unrealized holding gain (loss) arising during the period (30,042) 74,067 61,649

Unrealized gain/loss on cash flow hedges:

Unrealized holding gain (loss) arising during the period 138 (1,480) (1,072)

Defined benefit pension plans:

Net gain (loss) arising during the period 9,482 (2,237) 5,796

Reclassification adjustment for amortization of prior service cost 84 84 106

See NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

Preferred Common Stock

Comprehensive income

Other comprehensive income (loss), net of tax — — — — — — 49,296 49,296

Cash dividends on common stock ($1.00 per share) — — — — — (51,276) — (51,276)

Stock issued under employee benefit plans — — 21,521 3 699 — — 702

Restricted shares withheld for taxes — — (43,093) (6) (1,674) — — (1,680)

Comprehensive income

Other comprehensive income (loss), net of tax — — — — — — 46,962 46,962

Cash dividends on common stock ($1.04 per share) — — — — — (56,542) — (56,542)

Stock issued under employee benefit plans — — 25,423 3 636 — — 639

Restricted shares withheld for taxes — — (39,757) (6) (974) — — (980)

Cumulative effect of ASC 326 adoption — — — — — (68,040) — (68,040)

Comprehensive income

Other comprehensive income (loss), net of tax — — — — — — (19,723) (19,723)

Cash dividends on common stock ($1.13 per share) — — — — — (61,230) — (61,230)

Stock issued under employee benefit plans — — 16,507 2 603 — — 605

Restricted shares withheld for taxes — — (38,024) (4) (1,609) — — (1,613)

See notes to consolidated financial statements.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF CASH FLOWS

December 31, December 31, December 31,

Cash Flow From Operating Activities:

Gains on sales of securities available for sale (5,674) (11,895) (4,415)

Increase in cash surrender of life insurance (4,873) (5,040) (4,518)

Gains on life insurance benefits (2,187) (100) (19)

Cash Flows from Investing Activities:

Purchases of:

Proceeds from maturities of:

Net cash and cash equivalents received (paid) in acquisition (2,933) — 10,207

Proceeds from the sale of other real estate owned 706 8,655 2,060

Proceeds from life insurance benefits 8,764 601 815

Proceeds from mortgage portfolio loan sale 78,159 — —

Cash Flows from Financing Activities:

Net change in :

Stock issued under employee benefit plans 605 639 702

Additional cash flow information:

Loans transferred to other real estate owned 292 813 7,031

Fixed assets transferred to other assets 6,384 262 1,210

Non-cash investing activities using trade date accounting 39,923 6,183 —

CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

In conjunction with the acquisitions, liabilities were assumed as follows:

Cash received (paid) in acquisition (3,225) — (15)

Less: Common stock issued — — 229,926

See notes to consolidated financial statements.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

NOTE 1

NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

FINANCIAL STATEMENT PREPARATION

The accounting and reporting policies of the Corporation and the Bank, conform to accounting principles generally accepted in the United States of America and reporting practices followed by the banking industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for credit losses and fair value of financial instruments.Reclassifications have been made to prior financial statements to conform to the current financial statement presentation. The uncertainties related to COVID-19 could cause significant changes to these estimates compared to what was known at the time these financial statements were prepared.

The Corporation is a financial holding company whose principal activity is the ownership and management of the Bank and operates in a single significant business segment. The Bank provides full banking services under an Indiana state-charter. Additionally, the Bank operates as First Merchants Private Wealth Advisors (a division of First Merchants Bank). The Bank generates commercial, mortgage, and consumer loans and receives deposits from customers located primarily in central and northern Indiana, northeast Illinois, central Ohio and southeast Michigan counties. The Bank’s loans are generally secured by specific items of collateral, including real property, consumer assets and business assets.

A brief description of current accounting practices and current valuation methodologies are presented below.

CONSOLIDATION

The consolidation of the Corporation's financial statements include the accounts of the Corporation and all its subsidiaries, after elimination of all material intercompany transactions.

BUSINESS COMBINATIONS

Business combinations are accounted for under the acquisition method of accounting. Under the acquisition method, assets and liabilities of the business acquired are recorded at their estimated fair values as of the date of acquisition with any excess of the cost of the acquisition over the fair value of the net tangible and intangible assets acquired recorded as goodwill. Results of operations of the acquired business are included in the income statement from the date of acquisition. Details of the Corporation's acquisitions are included in NOTE 2. ACQUISITIONS of these Notes to Consolidated Financial Statements.

CASH AND CASH EQUIVALENTS

Cash on hand, cash items in process of collection and non-interest bearing cash held at various banks are included in cash and cash equivalents and have a maturity of less than three months. The Corporation maintains deposits with other financial institutions in amounts that exceed federal deposit insurance coverage. Management regularly evaluates the credit risk associated with the counterparties to these transactions and believes there is not significant credit risk on cash and cash equivalents.

INTEREST-BEARING DEPOSITS

Interest-bearing cash held at various banks and the Federal Reserve Bank and federal funds sold are included in interest-bearing deposits and have a maturity of less than three months. The Corporation maintains deposits with other financial institutions in amounts that exceed federal deposit insurance coverage. Management regularly evaluates the credit risk associated with the counterparties to these transactions and believes there is not significant credit risk on interest-bearing deposits.

INVESTMENT SECURITIES

Held to maturity securities are carried at amortized cost when the Corporation has the positive intent and ability to hold them until maturity. Available for sale securities are recorded at fair value on a recurring basis with the unrealized gains and losses, net of applicable income taxes, recorded in other comprehensive income (loss). Realized gains and losses are recorded in earnings and the prior fair value adjustments are reclassified within stockholders' equity. Gains and losses on sales of securities are determined on the specific-identification method. Amortization of premiums and accretion of discounts are amortized to their earliest call date and are recorded as interest income from securities. Details of the Corporation's investment securities portfolio are included in NOTE 4. INVESTMENT SECURITIES of these Notes to Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

ALLOWANCE FOR CREDIT LOSSES ON INVESTMENT SECURITIES AVAILABLE FOR SALE

For investment securities available for sale in an unrealized loss position, the Corporation first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For investment securities available for sale that do not meet the aforementioned criteria, the Corporation evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, the Corporation considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded, limited by the amount that the fair value is less than the amortized cost basis. Unrealized losses that have not been recorded through an allowance for credit losses are recognized in other comprehensive income. Adjustments to the allowance for credit losses are reported in the income statement as a component of the provision for credit loss. The Corporation has made the accounting policy election to exclude accrued interest receivable on investment securities available for sale from the estimate of credit losses. Investment securities available for sale are charged off against the allowance or, in the absence of any allowance, written down through the income statement when deemed uncollectible or when either of the aforementioned criteria regarding intent or requirement to sell is met. The Corporation did not record an allowance for credit losses on its investment securities available for sale as the unrealized losses were attributable to changes in interest rates, not credit quality. Details of the Corporation's allowance for credit losses on investment securities available for sale are included in NOTE 4. INVESTMENT SECURITIES of these Notes to Consolidated Financial Statements.

ALLOWANCE FOR CREDIT LOSSES ON INVESTMENT SECURITIES HELD TO MATURITY ("ACL - INVESTMENTS")

The ACL - Investments is a contra asset-valuation account that is deducted from the amortized cost basis of investment securities held to maturity to present the net amount expected to be collected. Investment securities held to maturity are charged off against the ACL - Investments when deemed uncollectible. Adjustments to the ACL - Investments are reported in the income statement as a component of the provision for credit loss. The Corporation measures expected credit losses on held to maturity debt securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The Corporation has made the accounting policy election to exclude accrued interest receivable on investment securities held to maturity from the estimate of credit losses. With regard to U.S. Government-sponsored agency and mortgage-backed securities, all these securities are issued by a U.S. government-sponsored entity and have an implicit or explicit government guarantee. With regard to securities issued by states and municipalities and other investment securities held to maturity, management considers (1) issuer bond ratings, (2) the financial condition of the issuer, (3) historical loss rates for given bond ratings, and (4) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities. Historical loss rates associated with securities having similar grades as those in the Corporation's portfolio have generally not been significant. An allowance for credit losses of $245,000 was recorded on state and municipal securities classified as held to maturity based on applying the long-term historical credit loss rate, as published by Moody’s, for similarly rated securities. Details of the Corporation's ACL - Investments are included in NOTE 4. INVESTMENT SECURITIES of these Notes to Consolidated Financial Statements. The Corporation adopted CECL on January 1, 2021 and the impact at adoption is described below under the heading "RECENT ACCOUNTING CHANGES ADOPTED IN 2021."

LOANS HELD FOR SALE

Loans originated and with an intent to sell are classified as held for sale and are carried at the principal amount outstanding. The carrying amount approximates fair value due to the short duration between origination and the date of sale.

LOANS

The Corporation’s loan portfolio is carried at the principal amount outstanding, net of unearned income and principal charge-offs. Loan origination fees, net of direct loan origination costs, and commitment fees are deferred and amortized as an adjustment to yield over the life of the loan, or over the commitment period, as applicable. Interest income is accrued on the principal balances of loans. The accrual of interest is discontinued on a loan when, in management’s opinion, the borrower may be unable to meet payments as they become due. When the interest accrual is discontinued, all unpaid accrued interest is reversed against earnings when considered uncollectible. Interest income accrued in the prior year, if any, is charged to the allowance for credit losses. Interest income is subsequently recognized only to the extent cash payments are received and the loan is returned to accruing status.

The Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) established the Paycheck Protection Program (“PPP”), which is administered by the Small Business Administration (“SBA”), to fund payroll and operational costs of eligible businesses, organizations and self-employed persons during the pandemic. The Bank actively participated in assisting its customers with PPP funding during all phases of the program. The vast majority of the Bank’s PPP loans made in 2020 have two-year maturities, while the loans made in 2021 have five-year maturities. Loans under the program earn interest at a fixed rate of 1 percent. As of December 31, 2021, the Corporation had $106.6 million of PPP loans compared to the December 31, 2020 balance of $667.1 million. The Corporation will continue to monitor legislative, regulatory, and supervisory developments related to the PPP. However, it anticipates that the majority of the Bank’s remaining PPP loans will be forgiven by the SBA in accordance with the terms of the program.

Loan commitments and letters-of-credit generally have short-term, variable-rate features and contain clauses which limit the exposure to changes in customer credit quality. Accordingly, their carrying values, which are immaterial at the respective balance sheet dates, are reasonable estimates of fair value. Details of the Corporation's loan portfolio are included in NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of these Notes to Consolidated Financial Statements.

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PURCHASED CREDIT DETERIORATED ("PCD") LOANS

The Corporation has purchased loans, some of which have experienced more than insignificant credit deterioration since origination. PCD loans are recorded at the amount paid. An allowance for credit losses is determined using the same methodology as other loans held for investment. The initial allowance for credit losses determined on a collective basis is allocated to individual loans. The sum of the loan’s purchase price and allowance for credit losses becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is the noncredit discount or premium, which is amortized into interest income over the life of the loan. Subsequent changes to the allowance for credit losses are recorded through the provision for credit losses.

ALLOWANCE FOR CREDIT LOSSES - LOANS ("ACL - Loans")

The ACL - Loans is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on loans over the contractual term. Loans are charged off against the allowance when the uncollectibility of the loan is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged off and expected to be charged off. Adjustments to the ACL - Loans are reported in the income statement as a component of provision for credit loss. The Corporation has made the accounting policy election to exclude accrued interest receivable on loans from the estimate of credit losses. Further information regarding the policies and methodology used to estimate the ACL - Loans is detailed in NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of these Notes to Consolidated Financial Statements. The Corporation adopted CECL on January 1, 2021 and the impact at adoption is described below under the heading "RECENT ACCOUNTING CHANGES ADOPTED IN 2021."

ALLOWANCE FOR LOAN LOSSES (prior to January 1, 2021 CECL adoption)

The Corporation's allowance for loan losses was maintained to absorb losses inherent in the loan portfolio and was based on ongoing, quarterly assessments of the probable losses inherent in the loan portfolio. The allowance was increased by the provision for loan losses, which was charged against current operating results. Loan losses were charged against the allowance when management believed the uncollectability of a loan was confirmed. Subsequent recoveries, if any, were credited to the allowance. The Corporation’s strategy for credit risk management included credit policies and underwriting criteria for all loans, as well as an overall credit limit for each customer significantly below legal lending limits. The strategy also emphasized diversification on regional geographic and industry levels, regular credit quality reviews and management reviews of large credit exposures and loans experiencing deterioration of credit quality.

The Corporation’s methodology for assessing the appropriateness of the allowance consisted of three key elements – the determination of the appropriate reserves for impaired loans accounted for under ASC 310-10, probable losses estimated from historical loss rates, and probable losses resulting from economic, environmental, qualitative or other deterioration above and beyond what were reflected in the first two components of the allowance.

Where appropriate, reserves were allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Corporation. Loans individually evaluated for impairment were those deemed impaired in accordance with ASC 310-10, including commercial relationships greater than $500,000 that exhibited well defined credit weaknesses. Any allowances for impaired loans were measured based on the fair value of the underlying collateral, if collateral dependent, or the present value of expected future cash flows discounted at the loan’s effective interest rate. The Corporation evaluated the collectability of principal when assessing the need for a loss accrual. Historical loss rates were applied to other commercial loans not subject to specific reserve allocations.

The historical allocation for commercial loans graded pass were established by loan segments using loss rates based on the Corporation’s migration analysis. This migration analysis showed the loss rates for each segment of loans based on the loan grades at the beginning of the twelve month period. This loss rate was then applied to the current portfolio of loans in each respective loan segment.

Homogenous loans, such as consumer installment and residential mortgage loans, were not individually risk graded. Reserves were established for each segment of loans using loss rates based on charge-offs for the same period as the migration analysis used for commercial loans.

In addition to the specific reserves and historical loss components of the allowance, consideration was given to various environmental factors to help ensure that losses inherent in the portfolio were reflected in the allowance for loan losses. Factors which management considered in the analysis included the effects of the national and local economies, trends in loan growth and charge-off rates, changes in mix, concentration of loans in specific industries, asset quality trends (delinquencies, charge-offs and non-accrual loans), risk management and loan administration, changes in the internal lending policies and credit standards, examination results from bank regulatory agencies and the Corporation’s internal loan review.

PENSION

The Corporation has defined-benefit pension plans, including non-qualified plans for certain employees, former employees and former non-employee directors. In 2005, the Board of Directors of the Corporation approved the curtailment of the accumulation of defined benefits for future services provided by certain participants in the First Merchants Corporation Retirement Plan. No additional pension benefits have been earned by any employees who had not met certain requirements as of March 1, 2005. The benefits are based primarily on years of service and employees’ pay near retirement. The Corporation's accounting policies related to pensions and other post retirement benefits reflect the guidance in ASC 715, Compensation – Retirement Benefits. The Corporation does not consolidate the assets and liabilities associated with the pension plan. Instead, the Corporation recognizes the funded status of the plan in the consolidated balance sheets. The measurement of the funded status and the annual pension expense involves actuarial and economic assumptions. Various statistical and other factors, which attempt to anticipate future events, are used in calculating the expense and liabilities related to the plans. Key factors include assumptions on the expected rates of return on plan assets, discount rates, expected rates of salary increases and health care costs and trends. The Corporation considers market conditions, including changes in investment returns and interest rates in making these assumptions. The primary assumptions used in determining the Corporation’s pension and post retirement benefit obligations and related expenses are presented in NOTE 18. PENSION AND OTHER POST RETIREMENT BENEFIT PLANS of these Notes to Consolidated Financial Statements.

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PREMISES AND EQUIPMENT

Premises and equipment is carried at cost net of accumulated depreciation. Depreciation is computed using the straight-line and declining balance methods based on the estimated useful lives of the assets ranging from three to forty years. Maintenance and repairs are expensed as incurred, while major additions and improvements, which extend the useful life, are capitalized. Gains and losses on dispositions are included in current operations. Details of the Corporation's premises and equipment are included in NOTE 6. PREMISES AND EQUIPMENT of these Notes to Consolidated Financial Statements.

LEASES

The Corporation leases certain land and premises from third parties and all are classified as operating leases. Operating leases are included in Other Assets and Other Liabilities on the Corporation's Consolidated Balance Sheets and lease expense for lease payments is recognized on a straight-line basis over the lease term. Right of Use ("ROU") assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the term. An ROU asset represents the right to use the underlying asset for the lease term and also includes any direct costs and payments made prior to lease commencement and excludes lease incentives. When an implicit rate is not available, an incremental borrowing rate based on the information available at commencement date is used in determining the present value of the lease payments. A lease term may include an option to extend or terminate the lease when it is reasonably certain the option will be exercised. Short-term leases of twelve months or less are excluded from accounting guidance; as a result, the lease payments are recognized on a straight-line basis over the lease term and the leases are not reflected on the Corporation's Consolidated Balance Sheets. Renewal and termination options are considered when determining short-term leases. Leases are accounted for at the individual level. Details of the Corporation's leases are included in NOTE 9. LEASES of these Notes to Consolidated Financial Statements.

FEDERAL HOME LOAN BANK STOCK ("FHLB")

FHLB stock is a required investment for institutions that are members of the FHLB. The Bank is a member of the FHLB of Indianapolis. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

INTANGIBLE ASSETS

Intangible assets that are subject to amortization, including core deposit intangibles, are being amortized on both the straight-line and accelerated basis over two to ten years. Intangible assets are periodically evaluated as to the recoverability of their carrying value. Details of the Corporation's other intangible assets are included in NOTE 8. OTHER INTANGIBLES of these Notes to Consolidated Financial Statements.

GOODWILL

Goodwill is maintained by applying the provisions of ASC 350, Intangibles – Goodwill and Other. For acquisitions, assets acquired, including identified intangible assets, and the liabilities assumed are required to be recorded at their fair value. These often involve estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analysis or other valuation techniques that may include estimates of attrition, inflation, asset growth rates, or other relevant factors. In addition, the determination of the useful lives over which the intangible asset will be amortized is subjective.

Under ASC 350, the Corporation is required to evaluate goodwill for impairment on an annual basis, as well as on an interim basis, if events or changes indicate that the asset may be impaired, indicating that the carrying value may not be recoverable. The Corporation completed its most recent annual goodwill impairment test as of October 1, 2021 and concluded, based on current events and circumstances goodwill is not impaired. Details of the Corporation's goodwill are included in NOTE 7. GOODWILL of these Notes to Consolidated Financial Statements.

BANK OWNED LIFE INSURANCE ("BOLI")

BOLI policies have been purchased, as well as obtained through acquisitions, on certain current and former employees and directors of the Corporation to offset a portion of the employee benefit costs. The Corporation records the life insurance at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or amounts due that are probable at settlement. Changes in cash surrender values and death benefits received in excess of cash surrender values are reported in non-interest income. A corporate policy is in place with defined thresholds that limit the amount of credit, interest rate and liquidity risk inherent in a BOLI portfolio. The Corporation actively monitors the overall portfolio performance along with the credit quality of the insurance carriers and the credit quality and yield of the underlying investments.

OTHER REAL ESTATE OWNED ("OREO")

OREO consists of assets acquired through, or in lieu of, loan foreclosure and are held for sale. They are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation are included in other real estate owned and foreclosure expenses.

DERIVATIVE INSTRUMENTS

Derivative instruments, which are recorded as assets or liabilities in the consolidated balance sheets, are carried at fair value of the derivatives and reflects the estimated amounts that would have been received to terminate these contracts at the reporting date based upon pricing or valuation models applied to current market information. As part of the asset/liability management program, the Corporation will utilize, from time to time, interest rate floors, caps or swaps to reduce its sensitivity to interest rate fluctuations. Changes in the fair values of derivatives are reported in the consolidated statements of operations or AOCI depending on the use of the derivative and whether the instrument qualifies for hedge accounting. The key criterion for hedge accounting is that the hedged relationship must be highly effective in achieving offsetting changes in those cash flows that are attributable to the hedged risk, both at inception of the hedge and on an ongoing basis.

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Derivatives that qualify for the hedge accounting treatment are designated as either: (1) a hedge of the fair value of the recognized asset or liability, or of an unrecognized firm commitment (a fair value hedge); or (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (a cash flow hedge). To date, the Corporation has only entered into a cash flow hedge. For cash flow hedges, changes in the fair values of the derivative instruments are reported in AOCI to the extent the hedge is effective. The gains and losses on derivative instruments that are reported in AOCI are reflected in the consolidated statements of income in the periods in which the results of operations are impacted by the variability of the cash flows of the hedged item. Generally, net interest income is increased or decreased by amounts receivable or payable with respect to the derivatives, which qualify for hedge accounting. At inception of the hedge, the Corporation establishes the method it uses for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. The ineffective portion of the hedge, if any, is recognized in the consolidated statements of income. The Corporation excludes the time value expiration of the hedge when measuring ineffectiveness.

The Corporation offers interest rate derivative products (e.g. interest rate swaps) to certain of its high-quality commercial borrowers. This product allows customers to enter into an agreement with the Corporation to swap their variable rate loan to a fixed rate. These derivative products are designed to reduce, eliminate or modify the risk of changes in the borrower’s interest rate or market price risk. The extension of credit incurred through the execution of these derivative products is subject to the same approvals and rigorous underwriting standards as the related traditional credit product. The Corporation limits its risk exposure to these products by entering into a mirror-image, offsetting swap agreement with a separate, well-capitalized and rated counterparty previously approved by the Credit and Asset Liability Committee. By using these interest rate swap arrangements, the Corporation is also better insulated from the interest rate risk associated with underwriting fixed-rate loans. These derivative contracts are not designated against specific assets or liabilities under ASC 815, Derivatives and Hedging, and, therefore, do not qualify for hedge accounting. The derivatives are recorded on the balance sheet at fair value and changes in fair value of both the customer and the offsetting swap agreements are recorded (and essentially offset) in non-interest income. The fair value of the derivative instruments incorporates a consideration of credit risk (in accordance with ASC 820, Fair Value Measurements and Disclosures), resulting in some volatility in earnings each period. Details of the Corporation's derivative instruments are included in NOTE 12. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES of these Notes to Consolidated Financial Statements.

SECURITIES SOLD UNDER REPURCHASE AGREEMENTS

Securities sold under repurchase agreements represent securities the Corporation routinely sells to certain treasury management customers and then repurchases these securities the next day. Securities sold under repurchase agreements are reflected as secured borrowings in the consolidated balance sheets at the amount of cash received in connection with each transaction. Details of the Corporation's repurchase agreements are included in NOTE 11. BORROWINGS of these Notes to Consolidated Financial Statements.

ALLOWANCE FOR CREDIT LOSSES - OFF-BALANCE SHEET CREDIT EXPOSURES

The allowance for credit losses on off-balance sheet credit exposures is a liability account representing expected credit losses over the contractual period for which the Corporation is exposed to credit risk resulting from a contractual obligation to extend credit. No allowance is recognized if the Corporation has the unconditional right to cancel the obligation. Off-balance sheet credit exposures primarily consist of amounts available under outstanding lines of credit and letters of credit. For the period of exposure, the estimate of expected credit losses considers both the likelihood that funding will occur and the amount expected to be funded over the estimated remaining life of the commitment or other off-balance sheet exposure. The likelihood and expected amount of funding are based on historical utilization rates. The amount of the allowance represents management’s best estimate of expected credit losses on commitments expected to be funded over the contractual life of the commitment. The allowance for off-balance sheet credit exposures is adjusted through the income statement as a component of provision for credit loss. Further information regarding the policies and methodology used to estimate the allowance for credit losses on off-balance sheet credit exposures is detailed in NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of these Notes to Consolidated Financial Statements. The Corporation adopted CECL on January 1, 2021 and the impact at adoption is described below under the heading "RECENT ACCOUNTING CHANGES ADOPTED IN 2021."

REVENUE RECOGNITION

Revenue recognitionguidance establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity's contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.

The majority of the Corporation's revenue-generating transactions are not subject to ASU 2014-09, including revenue generated from financial instruments, such as loans, letters of credit, derivatives and investment securities, as well as revenue related to mortgage servicing activities, as these activities are subject to other GAAP discussed elsewhere within the disclosures. The Corporation has evaluated the nature of its contracts

with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. Descriptions of revenue-generating activities that are within the scope of ASU 2014-09, which are presented in our income statements are as follows:

Service charges on deposit accounts: The Corporation earns fees from its deposit customers for transaction-based, account maintenance and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering and ACH fees, are recognized at the time the transaction is executed, which is the point in time the Corporation fulfills the customer's request. Account maintenance fees, which relate primarily to monthly maintenance, are earned monthly, representing the period which the Corporation satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer's account balance.

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Fiduciary activities: This represents monthly fees due from wealth management customers as consideration for managing the customers' assets. Wealth management and trust services include custody of assets, investment management, fees for trust services and similar fiduciary activities. These fees are primarily earned over time as the Corporation provides the contracted monthly or quarterly services and are generally assessed based on the market value of assets under management at month-end. Fees that are transaction-based are recognized at the point in time that the transaction is executed.

Investment Brokerage Fees: The Corporation earns fees from investment brokerage services provided to its customers by a third-party service provider. The Corporation receives commissions from the third-party provider on a monthly basis based upon customer activity for the month. The fees are paid to us by the third party on a monthly basis and are recognized when received.

Interchange income: The Corporation earns interchange fees from debit and credit cardholder transactions conducted through the Visa and MasterCard payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized concurrent with the transaction processing services provided to the cardholder.

Gains (Losses) on Sales of OREO: The Corporation records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Corporation finances the sale of OREO to the buyer, the Corporation assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Corporation adjusts the transaction price and related gain (loss) on sale if a significant financing component is present.

TRANSFERS OF FINANCIAL ASSETS

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered, or in the case of a loan participation, a portion of the asset has been surrendered and meets the definition of a "participating interest." Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation and put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

SHARE-BASED COMPENSATION

Stock option and restricted stock award plans are maintained by the Corporation. The compensation costs are recognized for stock options and restricted stock awards issued to employees and directors based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options. The market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation expense is recognized over the appropriate service period, which is generally two to five years. Details of the Corporation's share-based compensation are included in NOTE 17. SHARE-BASED COMPENSATION of these Notes to Consolidated Financial Statements.

INCOME TAX

Income tax expense in the consolidated statements of income is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts from the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The Corporation files consolidated income tax returns with its subsidiaries. The Corporation is generally no longer subject to U.S. federal, state and local income tax examinations by tax authorities for tax years before 2018.

The Corporation accounts for income taxes under the provisions of ASC 740, Income Taxes, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Per the guidance in ASC 740, the Corporation has not identified any uncertain tax positions that it believes should be recognized in the financial statements. The Corporation reviews income tax expense and the carrying value of deferred tax assets and liabilities quarterly; as new information becomes available, the balances are adjusted, if applicable. The Corporation's policy is to recognize interest and penalties related to unrecognized tax benefits, if any, as a component of income tax expense. Details of the Corporation's income taxes are included in NOTE 19. INCOME TAX of these Notes to Consolidated Financial Statements.

NET INCOME PER SHARE

Basic net income per share is computed by dividing net income available to common shareholders by the weighted-average number of shares of common stock outstanding. Diluted net income per share is computed by dividing net income available to common shareholders by the weighted-average number of shares of common stock outstanding, plus the dilutive effect of outstanding stock options and non-vested restricted stock awards. Potentially dilutive common shares are excluded from the computation of diluted earnings per share in the periods where the effect would be antidilutive. Details of the Corporation's net income per share are included in NOTE 20. NET INCOME PER SHARE of these Notes to Consolidated Financial Statements.

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IMPACT OF COVID-19

On January 30, 2020, the World Health Organization (“WHO”) announced that the outbreak of COVID-19 constituted a public health emergency of international concern. On March 11, 2020, WHO declared COVID-19 to be a global pandemic and, on March 13, 2020, the President of the United States declared the COVID-19 outbreak a national emergency. In the two years since then, the pandemic has dramatically impacted global health and the economic environment, including millions of confirmed cases and deaths, business slowdowns or shutdowns, labor shortfalls, supply chain challenges, regulatory challenges, and market volatility. In response, the U.S. Congress, through the enactment of the CARES Act in March 2020, and the federal banking agencies, though rulemaking, interpretive guidance and modifications to agency policies and procedures, have taken a series of actions to provide emergency economic relief measures including, among others, the following:

Paycheck Protection Program. The CARES Act established the PPP, which is administered by the SBA, to fund payroll and operational costs of eligible businesses, organizations and self-employed persons during the pandemic. The Bank actively participated in assisting its customers with PPP funding during all phases of the program. The vast majority of the Bank’s PPP loans made in 2020 have two-year maturities, while the loans made in 2021 have five-year maturities. Loans under the program earn interest at a fixed rate of 1 percent. As of December 31, 2021, the Corporation had $106.6 million of PPP loans outstanding compared to the December 31, 2020 balance of $667.1 million. The Corporation will continue to monitor legislative, regulatory, and supervisory developments related to the PPP. However, it anticipates that the majority of the Bank’s remaining PPP loans will be forgiven by the SBA in accordance with the terms of the program

Loan Modifications and Troubled Debt Restructures. The CARES Act, as amended by the 2021 Consolidated Appropriations Act (the "2021 CAA"), allowed banks to suspend requirements under GAAP, effectively, through January 1, 2022, for certain loan modifications related to the COVID-19 pandemic. The federal banking agencies also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19 or offer other borrower friendly options. In accordance with such guidance, the Bank made various short-term modifications for borrowers who were current and otherwise not past due. These included short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that were insignificant.

The continued impact of COVID-19 on the Corporation will depend on numerous factors and future developments that are highly uncertain and cannot be predicted with confidence. It is unknown how long the COVID-19 pandemic will last, or when restrictions on individuals and businesses will be fully lifted and businesses and their employees will be able to resume normal activities. Additional information may emerge regarding new developments with COVID-19 and additional actions may be taken by federal, state and local governments to contain COVID-19 or treat its impact. Changes in the behavior of customers, businesses and their employees as a result of COVID-19 pandemic are also unknown. As a result of COVID-19 and the actions taken to contain it or reduce its impact, the Corporation may continue to experience changes in the demand for our products and services, changes in the value of collateral securing outstanding loans, reductions in the credit quality of borrowers and the inability of borrowers to repay loans in accordance with their terms. Commercial and consumer customers are experiencing varying degrees of financial distress, which is expected to continue into 2022, especially if positive cases increase and economic shutdowns are reinstated. These and similar factors and events may have substantial negative effects on the business, financial condition and results of operations of the Corporation and its customers.

RECENT ACCOUNTING CHANGES ADOPTED IN 2021

FASB Accounting Standards Updates No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

Summary - The FASB issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This new guidance replaced the previous “incurred loss” model for recognizing credit losses with an “expected life of loan loss” model referred to as the Current Expected Credit Loss ("CECL") model.